What Is a Discount Fee on a Mortgage Loan?

by William Pirraglia

What Is a Discount Fee on a Mortgage Loan?

Borrowers typically have a love-hate relationship with discount fees -- points. If you are a prospective homeowner, you're trying to conserve every penny of your available cash. However, choosing to pay one or more discount points means you'll enjoy a lower interest rate. Mortgage lenders will not require you to pay discount fees. Whether you choose to purchase points will depend on a number of factors, including, of course, your available cash.

Discount Fee Calculation

Discount fees are usually quoted as points. One point equals 1 percent of your mortgage amount. The discount you'll receive depends on your lender and the current state of the mortgage market. In all cases, however, discount fees are expressed as points -- or fractions thereof. For example, your lender may quote you a rate with one point, another rate with 1½ points and a third rate with two points. In all cases, each point equals 1 percent of your mortgage amount.

Amount of the Discount

The size of the discount you'll receive by paying one or more points varies with the lender and current mortgage rates. Understand that mortgage rates can remain stable for weeks at a time or change multiple times per day, depending on the current interest rate market. Use this rule of thumb: Often, paying one discount point reduces your interest rate by one-quarter to three-eighths of 1 percent. Therefore, should a no-point fixed rate be 6 percent, paying one point may reduce this rate to 5¾ percent.

Paying Discount Fees

When you purchase a home, you'll need to have hard cash to pay your discount fee. Understand that your discount points represent cash you need in addition to your other closing costs -- typically 1 to 3 percent of your purchase price. When you refinance, you'll usually have an additional option. Instead of bringing cash to your closing, you can have your discount points added to your new mortgage balance. This option means you will pay your discount fees over time, including interest, since your loan will be higher.

When to Choose Discount Fees

While everyone wants the lowest interest rate possible, you should evaluate the cost benefit of paying discount fees. If you have found your dream home and expect to keep it long-term, you may save many thousands of interest dollars by paying discount fees. Conversely, if you buy a starter home that you plan to own no longer than a few years, you might want to conserve your cash and opt for the no-point loan. The interest savings you enjoy over a few years may not equal the one-time cost of paying discount points.